welcome to the schneider downs quarterly not-for-profit
TRANSCRIPT
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Recent 403(b) Fiduciary Litigation Best Practices for Managing Fiduciary Obligations Under
Employer-Sponsored 403(b) Plans Presented by:
Bruce Gabler, Esquire, Cohen & Grigsby, P.C.
and Karl Kunkle, Schneider Downs Tax Shareholder and
CEO, SDAdvantage Retirement Solutions
Welcome to the Schneider Downs
Quarterly Not-for-Profit Breakfast Briefing
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* Page 1 of a 70 page complaint
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2. The duties of loyalty and prudence are the
“highest known to the law” and require fiduciaries
to have “an eye single to the interests of the
participants and beneficiaries.”
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2. Billion-dollar-defined contribution plans, like
the Plan, have significant bargaining power to
demand low-cost administrative and investment
management services.
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2. Defendants allowed unreasonable expenses
to be charged to participants for administration of
the Plan and retained high-cost and poor-
performing investments compared to available
alternatives.
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3. Plaintiffs bring this action on behalf of the
Plan under 29 U.S.C. §1132(a)(2) and (3) to
enforce Defendants’ personal liability.
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18. The University of Pennsylvania appointed
the Vice President of Human Resources of the
University of Pennsylvania to serve as the Plan
Administrator under 29 U.S.C. §1002(16)(A)(i).
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24. Defendants have provided as Plan
investment options mutual funds and insurance
company variable annuity products offered by the
Teachers Insurance and Annuity Association of
America and College Retirement Equities Fund
(“TIAA-CREF”) and the Vanguard Group, Inc.
(“Vanguard”).
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25. As of December 31, 2014, Defendants
selected a total of 78 investment options to provide
to Plan participants. Among the available
investments, 30 were TIAA-CREF investments,
and 48 were Vanguard investments.
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28. The TIAA Traditional Annuity has severe
restrictions and penalties for withdrawal if
participants wish to change their investments in
the Plan.
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30. The expense ratio of the CREF variable
annuity accounts is made up of multiple layers of
expense charges called:
a. “administrative expense” charge (24 bps);
b. “distribution expense” charge (9.5 bps);
c. “mortality and expense risk” charge (0.5 bps);
and
d. “investment advisory expense” charge
(ranging from 4 bps to 12.5 bps).
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37. To ensure that plan administrative and
recordkeeping expenses are and remain
reasonable for the services provided, prudent
fiduciaries of large defined contribution plans put
the plan’s recordkeeping and administrative
services out for competitive bidding at regular
intervals of approximately three years.
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38. The cost of recordkeeping services
depends on the number of participants, not on the
amount of assets in the participant’s account.
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40. In a revenue sharing arrangement, a mutual fund
or other investment vehicle directs a portion of the expense
ratio—the asset-based fees it charges to investors—to the
plan’s recordkeeper.... Because revenue sharing payments
are asset-based, they often bear no relation to a
reasonable recordkeeping fee and can provide excessive
compensation, or may be used as kickbacks to induce
recordkeepers to have their high priced funds included as
plan investment options.
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43. It is well known in the defined contribution plan industry that
plans with dozens of choices and multiple recordkeepers “fail” as a
model based on two primary flaws:
1. The choices are overwhelming. Numerous studies have
demonstrated that when people are given too many choices of
anything, they lose confidence or make no decision.
2. The multi-recordkeeper platform is inefficient. It does not
allow sponsors to leverage total plan assets and receive
appropriate pricing based on aggregate assets.
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45. In a study titled “How 403(b) Plans Are Wasting Nearly $10
Billion Annually, and What Can Be Done to Fix It”, AonHewitt, an
independent investment consultant, similarly recognized:
403(b) plan sponsors can dramatically reduce participant-borne
costs while improving employees’ retirement readiness by:
- Reducing the number of investment options, utilizing an
“open architecture” investment menu, and packaging the
options within a “tiered” structure.
- Consolidating recordkeepers to improve efficiencies and
reduce compliance-related risks.
- Leveraging aggregate plan size and scale to negotiate
competitive pricing.
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51. Upon information and belief and industry experts, the amount
of revenue sharing kicked back to the TIAA-CREF recordkeeping entity
for the Plan’s TIAA-CREF investments is set forth below:
TIAA-CREF Investment Revenue Share
CREF variable annuity contracts 24 bps
Premier share class of TIAA-CREF mutual funds
15 bps
Retirement share class of TIAA-CREF mutual funds
25 bps
TIAA Real Estate Account 24-26.5 bps
TIAA Traditional Annuity 15 bps
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54. Based on the Plan’s features, the nature of the
administrative services provided by Vanguard and
TIAA-CREF, the Plan’s participant level (roughly
20,000), and the recordkeeping market, the outside
limit of a reasonable recordkeeping fee for the Plan
would have been $700,000 to $750,000 (or $35 per
participant with an account balance).
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58. Upon information and belief, Defendants
also failed to conduct a competitive bidding
process for the Plan’s recordkeeping services.
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60. Nobel Prize winners in economics have
concluded that virtually no investment manager
consistently beats the market over time after fees
are taken into account.
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65. Indeed, funds with high fees on average
perform worse than less expensive funds even on
a pre-fee basis.
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69. Lower-cost share class identical alternatives to the
Plan's mutual funds included:
Plan Mutual Fund Plan Fee
Identical Lower- Cost Mutual Fund
Identical Lower-Cost
Mutual Fund Fee
Plan’s Excess Cost
Vanguard 500 Index Fund (Signal) (VIFSX)
7 bps Vanguard Institutional Index (Instl PI) (VIIIX)
2 bps 250%
Vanguard Asset Allocation Fund (Inv) (VAAPX)
27 bps Vanguard Asset Allocation Fund (Adm) (VAARX)
19 bps 42%
Vanguard Balanced Index Fund (Inv) (VBINX)
26 bps Vanguard Balanced Index Fund (Instl) (VBAIX)
8 bps 225%
* This comparison continues for eight pages
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71. The failure to select lower-cost share classes
for the Plan's mutual fund options identical in all
respects (portfolio manager, underlying investments,
and asset allocation) except for cost demonstrates that
Defendants failed to consider the size and purchasing
power of the Plan when selecting share classes and
failed to engage in a prudent process in the selection,
monitoring, and retention of those mutual funds.
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IV. Defendants selected and retained a large
number of duplicative investment options,
diluting the Plan’s ability to pay lower fees
and confusing participants.
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77. Unlike Defendants, prudent fiduciaries do
not select and retain numerous investment options
for a single asset class and investment style.
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78. In addition, providing multiple options in a
single investment style adds unnecessary
complexity to the investment lineup and leads to
participant confusion.
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81. For illustration purposes, the Plan’s four large cap domestic
blend investments as of December 31, 2014, are summarized below and
compared to a single lower-cost alternative that was available to the
Plan: the large cap blend Vanguard Institutional Index Fund-Instl. Plus
(VIIIX), which mirrors the market and has an expense ratio of 2 bps.
Large Cap Blend Investments
Assets Plan Fee
Lower-Cost Alternative
Fee
Plan’s Excess Cost
CREF Stock Account $753,152,128 46 bps 2 bps 2200%
CREF Equity Index Account $86,587,630 37 bps 2 bps 1750%
Vanguard Institutional Index Fund-Instl (VINIX)
$120,459,283 4 bps 2 bps 100%
Vanguard Total Stock Market Index Fund-Instl (VITSX)
$64,508,300 4 bps 2 bps 100%
Total $1,024,707,341
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90. Overall, Defendants failed to pool the
assets invested in duplicative funds into a single
investment option.
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94. As is generally understood in the
investment community, passively managed
investment options should be used. This is
because it is difficult and extremely unlikely to find
actively managed mutual funds that outperform a
passive index, net of fees, particularly on a
persistent basis.
* This continues for 20 pages
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124 c. Schlichter, Bogard & Denton handled
the only full trial of an ERISA excessive fee case,
resulting in a $36.9 million judgment for the
plaintiffs that was affirmed in part by the Eighth
Circuit. Tussey v. ABB Inc., 746 F.3d 327 (8th Cir.
2014).
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128. If a defined contribution plan overpays for
recordkeeping services due to the fiduciaries’
“failure to solicit bids” from other recordkeepers,
the fiduciaries have breached their duty of
prudence.
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130. Moreover, Defendants failed to solicit
competitive bids from vendors on a flat per-
participant fee.
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131. Total Plan losses will be determined at trial
after complete discovery in this case and are
continuing.
132. Each Defendant is personally liable under 29
U.S.C. §1109(a) to make good to the Plan any losses
to the Plan resulting from the breaches of fiduciary
duties alleged in this Count and is subject to other
equitable or remedial relief as appropriate.
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The lawyer, Jerome J. Schlichter, is a pioneer in retirement
plan litigation. Over the last decade, he has file more than 20
lawsuits on behalf of workers in 401(k) retirement plans.
Mr. Schlichter’s firm has settled about half of his 20 cases
over the last 10 years. His first case involving a 403(b) was
against Novant Health, a nonprofit hospital system, which settled
last year for $32 million.
M.I.T., N.Y.U. and Yale Are Sued Over Retirement Plan Fees
by Tara Siegel Bernard – August 9, 2016 (The New York Times)
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Some of the more prominent cases against 401(k) plans settled by
Mr. Schlichter include a $62 million settlement against Lockheed
Martin, $57 million from Boeing, and $27.5 million from Ameriprise, all
in 2015. He also settled cases with Cigna, International Paper,
Caterpillar, General Dynamics, Bechtel and Kraft.
Mr. Schlichter said his firm, which works on a contingency basis,
typically collects up to a third of the settlement, while the remainder
goes to the plaintiffs and members of the class.
M.I.T., N.Y.U. and Yale Are Sued Over Retirement Plan Fees
by Tara Siegel Bernard – August 9, 2016 (The New York Times)
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Law 360, New York (August 19, 2016, 8:31 PM ET) – Morgan Stanley and
its board were slammed with a $150 million potential class action lawsuit in
New York federal court Friday, accused of mismanaging the firm’s 401(k)
retirement plan by offering low-performing funds and charging excess fees.
The lawsuit, filed in the Southern District in Manhattan, claims Morgan
Stanley invests employees’ retirement savings into funds that consistently
underperform, including some of the mutual funds that are run by Morgan
Stanley itself.
Morgan Stanley Hit With $150M Suit Over 401(k) Management
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“Morgan Stanley should be held to the highest standard as a fiduciary;
instead, in this case, it falls below the lowest standard,” an attorney for the
plaintiffs, David Sanford of Sanford Heisler LLP, said in a statement.
Morgan Stanley Hit With $150M Suit Over 401(k) Management
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Best Practices For Managing Fiduciary Obligations Under 403(b) Plans
Presented by: Karl W. Kunkle, J.D. , CPA, PFS Schneider Downs & Co., Inc Schneider Downs Wealth Management Advisors, LP SDAdvantage Retirement Plan Solutions, LP
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ERISA
Employee Retirement Income Security Act of 1974
• FICUCIARIES– Who?
• FIDUCIARY DUTY-What?
• Authorizes Employees to Sue for Breach
• Generally applies to both 401(k) plans and 403(b) plans
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ERISA
• WHO?
– Persons with responsibility for engaging service providers or appointing fiduciaries (Employer Plan SponsorBoard of DirectorsCommittee)
– Named Fiduciaries including the Trustee, ERISA 3(21) or 3(38) fiduciaries
– Any person who has discretionary authority or control over the plan or plan assets or over the administration of the plan.
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ERISA
• DUTIES
– PRUDENCE
• Prudent Man Standard- “..discharge duties ..with the care, skill, prudence and diligence under the circumstances then prevailing that a prudent man, acting in a like capacity and familiar with such matters would use…”
– Engagement of professional advisors
– PROCESS (not results), therefore, document process and implementation of process
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Summary of Litigation Issues
• RECORDKEEPING
– Asset-based (basis point % charge) fees versus per participant fixed fee
– Multiple Recordkeepers
– Revenue Sharing
– Proprietary Funds with a focus on Stable Value vs Money Market
– Float
– Ongoing Process to Monitor Fees and Services
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Summary of Litigation Issues
• INVESTMENT-BASED CLAIMS
– Duplicative, Excessive and High-Cost Options
• Multiple funds in each asset class
• Lowest cost available share class?
• Cost/Return analyses
• Failure to provide passive/index options
• Structure- mutual fund, annuity, separate account or CIT’s
– Capital Preservation Fund- Stable Value Fund vs. Money Market
– Failure to have or follow a documented process to monitor and replace investment options (Investment Policy Statement)
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Best Practices- Fiduciary Structure
• Professional Fiduciary– 3(38) and/or 3(21)
• Appropriate Committee Members
• Independent Advisors
• Protections
– Fiduciary Liability Insurance
– Corporate/Organizational Indemnification
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Best Practices- Investment Policy Statement (IPS)
• Who? Identify Fiduciaries and Non-Fiduciary Advisors
• What? Identify Asset Classes
• How? Fund Selection and Monitoring Procedures
– Thresholds: Meet Criteria, Watch List, Replace
• Periodically Review
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Best Practices – Investment Selection and Monitoring
• Performance vs Benchmarks
• Asset Class Identification/Style Drift
• Expense Relative to Peers and Benchmarks
• Revenue Sharing Strategy
• Transfer Restrictions
• Share Class Optimization
• Active vs Indexing Strategy and Utilization
• Capital Preservation Fund Strategy- Stable Value vs. Money Market
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Best Practices- Recordkeeping Monitoring
• Periodic RFP Process
• Benchmarking of Fees
• Evaluation of Services and Service Delivery
• Asset-Based vs Per-Participant Fixed Fees
• Revenue Sharing- Understand and Measure Application and Utilization
• Float- Understand and Monitor
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Recommendations
• Read my Insight on Schneiderdowns.com for a short summary on this topic or contact me or your SD representative for a copy
• Consider and independent Fiduciary Check Up
• Consider conducting an RFP or a Fee Benchmarking Study
• Contact me or your SD representative for more information
Karl W. Kunkle, Shareholder
(412) 697-5401
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